What one ex-Fed official expects on tapering

Former Atlanta Fed research director sees small taper

WASHINGTON (MarketWatch) — A former Federal Reserve official says the central bank will get the process of tapering underway next week but leave the big decisions to outgoing Fed Chairman Ben Bernanke’s successor.

Robert Eisenbeis, the former research director at the Federal Reserve Bank of Atlanta and now chief monetary economist at Cumberland Advisors Inc., also said in an interview with MarketWatch that the central bank is overlooking one exit strategy that might limit market disruption.

Here’s an edited transcript.

MarketWatch: What do you think the Fed is going to do next week?

Eisenbeis: They are between a rock and a hard place, in many respects. At the time of the June meeting, the labor market looked a little better than what it does now after the revisions.The markets have priced in a tapering, and so now, if they don’t taper, they are essentially going to be disappointing markets, and that will cause further market turmoil at a time when we have uncertainty about Syria, we have uncertainty about what the budget situation is going to be, and they probably don’t want to do that.

So what I expect them to do is some modest amount of tapering — essentially to do something but not enough to cause a large disruption in the markets. So I think a small amount would be in the vicinity of $5 billion reduction in the rate of purchases and probably on the Treasury side rather than the mortgage side, given some of the papers that were presented out at the Jackson Hole conference arguing that there is more bang for the buck as far as the housing market is concerned by continuing support there relative to the Treasury market.

MarketWatch: Do you think the market has this priced in?

Eisenbeis: Oh, I think so. There shouldn’t be much reaction. There would be more reaction obviously if, in fact, they didn’t do anything. That would create further uncertainty. Failure to do something now, or at least to set a course, would essentially put in place the seeds for continued volatility for several months.

MarketWatch: And how do you see this playing out going forward — steady reductions?

Eisenbeis: Maybe no particular path. Because Bernanke’s successor will be appointed, and there is going to be a whole new cast of characters on the Federal Reserve Board and at the FOMC voting for next year. So making a small move now and then saying, “Well it’s everybody else’s turn to plot policy from there on out.” This would essentially hand it over to the new, reconstituted committee. None of those people are in place. We don’t even know who they are. To commit a new FOMC to a policy path that it had no role in deciding would be a bit of a stretch.

It would be less of an issue if Janet Yellen would be the appointee. If she were to be the nominee, I think we could see the continuation of tapering, but we know she is very cautious, so I wouldn’t see her pursuing a vigorous tapering path.

MarketWatch: And do you think the Fed can engineer this end of QE without roiling the markets?

Eisenbeis: No, I don’t see how they can. There is a disconnect in terms of how they are thinking about QE relative to how markets are thinking about it, and I don’t think they have fully internalized those differences yet. They have models that focus on the volume of outstanding reserves and the amount, the size of their portfolio as being the predominant policy tool and not the purchases. What they forget is that they have distorted the term structure. And so when you look at forward rates now you are not looking at market expectations in a normal environment but rather supply-constrained-generated expectations. And by that I mean the fact that if they start tapering and the pace of issuance of Treasurys continues at the current pace, then there will be increased supply relative to what there would have been in the market had the Fed not begun to scale back its purchases, and increased supply is going to put downward pressure on prices and upward pressures on rates. And that is where you get this signal effect manifesting itself, and I don’t think they fully appreciate that yet.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.